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Alternative investments: Why you shouldn't play the numbers game

Ian Warwick on why sector experts should be utilised for anyone considering investment in an alternative market.

Last year I was fortunate enough to be on a panel, with the theme being EIS investing, when the panel was asked, "how much of what you do is down to luck?"

To this question, a fellow panel member (and competitor) responded that "about 60% of what we do is down to luck." At this point, I nearly fell of my chair!

"The luck was the idea, the success was down to a hell of a lot of hard work, research, diligence and desire."

My answer to this question was entirely different and I'll tell you why. If you are investing by playing 'the numbers game,' i.e. you pick a number of EIS eligible companies just because they are eligible and your due diligence is based solely on financial results, then luck will play a massive part in your investment. If, however, you select companies to invest in based on your experience within a sector, and knowing how to grow a company within that sector, then there should be very little luck involved.

The 'luck' comes at the early stage of a business, with the idea or eureka moment. Taking it to market and growing the business is then about diligence, hard work and utilising relevant knowledge.

One of my favourite examples of this is a good friend of mine. The gentleman in question owned a couple of butchers' shops and was making a living but nothing more, when one day just before Christmas a customer called in and asked him if he could put together a meat hamper for a client. My friend had to ask what he meant, but once explained he realised this was a potential new market for him. He then went on to create a hamper business and earn a not inconsiderable amount of money doing so. The luck was the idea, the success was down to a hell of a lot of hard work, research, diligence and desire.

I am therefore confident in saying that almost nothing we do is down to luck. If we do our job correctly, know and understand the businesses we invest in and utilise sector experience then we are not reliant on luck. Yes, any small unlisted investment carries greater risk than normal but when things don't go as well as planned we will able to understand why and usually it will be because something was done incorrectly rather than just being ‘unlucky’.

My recommendation to anyone considering investment in an alternative investment, such as EIS, is to utilise sector experts. By that, I mean a manager who can demonstrate clear understanding of the sector into which they are investing. For example; if you want to invest in media, use a manager who knows this industry inside out and similarly if you want to invest in technology or life sciences, identify a team that has considerable experience in the respective sector. Look for specific experience, don't try and play the numbers game. Your due diligence should identify who the key decision makers are within the manager and how much relevant experience they have. When investing in small unlisted companies; would you rather your clients' investment was overseen by someone with experience in the City or someone who has built businesses, has sector experience and knowledge and who will take a hands-on approach to mentoring and supporting the underlying invested company?